Credit unions get OK for equity, VC investing

WEST MICHIGAN — Small businesses across Michigan could soon have a new source to tap for investment capital: credit unions.

After successfully moving deeper into business services and commercial lending in the last few years, state-chartered credit unions now have the authority to invest in credit union service organizations, or CUSOs, that can make private equity and venture capital investments.

That could put up to another $30 million on the table to help grow the state’s small businesses, experts say.

The August ruling from the Michigan Office of Financial and Insurance Regulation could generate another potential source of capital for small businesses at a time when the state wants to build support networks for entrepreneurs and second-stage companies.

“I suspect there’s going to be some pretty good activity in the aftermath of this order,” said Steven Buquicchio, a law partner at the Grand Rapids office of Varnum LLP who works with credit unions and banks.

Buquicchio expects both large and small credit unions to work with a CUSO in which they hold a stake to branch into equity and venture investing. The credit unions that have been “very aggressive” in their markets will make the first moves, setting the stage for others to follow, he said.

“What you’re going to see first is a dipping of the toe in the water to see how this works,” Buquicchio said. “If some credit unions do it, you’ll see a domino effect and others will do it.”

The order from OFIR Commissioner R. Kevin Clinton stems from a February request from Wanigas Credit Union in Saginaw to examine the issue. In his Aug. 17 decision, Clinton ruled that under state law, his office may allow CUSOs to provide additional services to credit union members such as venture and equity investing in small businesses. His order also established criteria and limitations for investments that include capping an individual credit union’s investment in a CUSO at 10 percent of its assets.

Clinton wrote that allowing credit unions to become involved in venture and equity investing through a CUSO puts them on the same ground as banks and enables them to better compete. Under the law, “it is necessary and proper for CUSOs to offer small business equity and venture capital investment administration and related services to its related credit unions and their respective members,” Clinton’s order stated.

“Small business equity and venture capital fund investment administration services provided by CUSOs are appropriate and necessary in order for domestic credit unions to compete with other providers of financial service in this state,” Clinton wrote. “CUSOs have the ability to offer additional services in a safe and sound manner, and state-chartered credit unions are subject to limitations and controls sufficient to ensure that any investment in CUSOs offering such additional services is exercised in a safe and sound manner.”

Formed by one or more individual credit unions, CUSOs provide an array of shared administrative services to their members. Their services range from data processing and call centers to underwriting residential mortgages and commercial loans, for instance.

“Business investing authority has tremendous potential benefits to credit unions and to the small business community at large,” Adams said. “The objective is not return on investment. The ultimate objective is to help small businesses with alternative forms of capital.”

The first step toward that end is crafting a business model for credit unions to use to move into equity and venture investing. At this point, Adams said, “we don’t know exactly what the business model is going to look like,” although one potential element is to offer investments as convertible loans.

CUcorp, the trade association’s credit union service organization, “plans to work aggressively” to take advantage of the opportunity, Adams said. He expects it take six to 12 months to have a structure in place to make investments.

Working through a CUSO, credit unions in Michigan could back as many as 20 to 30 small businesses in their first year of investing, “and then you ramp up from there,” Adams said.

“Credit unions have a lot of money to invest,” he said. “There’s definitely an appetite for investment.”

Adams believes participants could reasonably invest a combined $30 million into CUSOs for equity or venture funds, an amount that “could make a real impact on a lot of small businesses,” he said.

By comparison, venture capitalists put $191 million into 38 deals in Michigan, including 22 startup companies that received first-round funding last year. Angel investors last year put another $9.5 million into 50 deals.

The primary targets for equity or venture investments are young companies seeking capital to move to the second stage. Adams sees most of the equity and venture investments going to second-stage companies, saying “it’s very difficult to invest in an idea” on which a startup is based.

“Once you have a second-stage business that is showing strength in their sales and has shown the ability to manage to a profit, then those are the businesses that are easier to take on risk,” Adams said.

Despite the potential, Adams sees equity and venture investing as a niche service for credit unions.

“It’s another tool credit unions will have, but I don’t think it’s anything that will overshadow their core business,” he said.

As with any new business venture, however, the key is getting the expertise to manage it and to make investment decisions, Adams said.

While equity and venture investing has its risks, Varnum’s Buquicchio believes credit unions can develop or acquire the expertise needed to do it effectively. He notes that many credit unions have broken into for commercial lending and have consistently grown their volumes without difficulties.

“These are well-run, strategic organizations,” Buquicchio said. “They are well-managed and well-advised and their boards are top-notch.”